Market Commentary - Current Volatility
“The stock market is a device for transferring money from the impatient to the patient” – Warren Buffett
Buffett has many timeless quotes, but there are none that ring truer in the current environment. I don’t know if we have seen the bottom, or not, but I do know investors have started to get very impatient which led to much of the irrational market moves we saw last week. This type of selling is usually a good sign for those who can bear the volatility and remain patient. Jason Zweig concludes in his book Your Money & Your Brain – “that financial losses are processed in the same area of the brain that responds to mortal danger.” It is no wonder why being “patient” is so difficult when the markets are under pressure and portfolio losses mount in real life.
Points to Consider
We can all agree that we are in the midst of a bear market. The question remains if this will be a recessionary bear-market or a non-recessionary bear market. I can make an argument for both cases, but I think the following provides some interesting data plots.
Job Openings versus Unemployed Persons
I find this chart encouraging. This market crash is very different from past crashes as the economy has thus far remained strong. Don’t get me wrong, inflation and rising rates will have an impact, but if you look at the number of job openings (orange line) relative to unemployed persons (purple line) there are almost two jobs available for each unemployed individual. I find this encouraging because most of the time when we see market crashes we are also dealing with an economic contraction where people are losing jobs, companies are going out of business, and consumer demand wanes. Today, we are faced with a record number of job openings and not enough people to fill them.
YTD Asset Class Returns
The second chart shows the YTD market performance for a select set of asset classes. One can easily conclude that things have been relatively bad across the board in 2022. In fact, this is the second worst start to a year in US market history. With that grim news behind us, I think we can glean a few things from this chart. 1) Diversification is still king, 2) Valuations are starting to look attractive, 3) Equities and fixed income have both been impacted, and 4) Cryptocurrencies have not provided the hedge against market volatility and inflation, as promised.
Diversification – The middle trend lines represent the YTD performance for the US, international, technology, small cap, and fixed income indices. The two outside trend lines show the dollar (dark green) and Bitcoin index (brown) YTD. The only free lunch in investing is diversification. In 2021, big tech and growth names were king. Today, we have seen these names roll over and commodities and value orientated names have shined. Being diversified softens the blow while providing ample exposure to various asset classes and stock holdings.
Valuations - Stocks are getting cheaper. A benefit from the YTD drawdown is that mid and small cap stocks are now cheaper than they were during the 2018 bear market and are approaching levels we saw during the COVID crash in March 2020. In summary, current returns are falling, but expected returns are rising, which is a long-term positive.
Equities & Fixed Income – This market crash has felt a bit more painful because both equities and fixed income have been crushed at the same time. YTD the US Aggregate bond index is down almost 10%. There have been few safe havens during this correction. The positive for bond holders is that the increase in interest rates will allow for the reinvestment of maturing bonds at higher rates, benefiting future fixed income returns. In all, future returns should be better for both equities and fixed income alike as we move forward.
Cryptocurrencies – We have no plans to add cryptocurrencies as an asset class to our models. We feel there is too much uncertainty around future regulation and it is to early to tell if cryptocurrencies can be a reliable asset class that provides diversification benefits. The argument behind cryptocurrencies is that they would provide a stable currency and hedge against inflation, while also minimizing volatility in down markets. What we have seen YTD is the opposite effect with the dollar still reigning king, up 9% YTD, while the Bitcoin index is down 36%. Many of the other cryptos are down far more. This is a not us taking a victory lap, but a realization that there is still a lot of unknown risk around these assets. We will continue to evaluate the role of cryptos and are happy to announce that one of our financial planners, Austin Angel, is getting Certified Digital Asset Advisor (CDAA) certification to help continue our research in this space.
I believe the charts and data shared above can form an argument that we are closer to a bottom than not. I think there is a reasonable probability that this becomes a non-recessionary bear market, and the worst may very well be behind us. However, there are always two sides to every argument, and the elephant in the room is inflation. So let me expand on the one risk that still provides me the greatest level of uncertainty that could continue to weigh down the markets.
Inflation is a real concern as it removes purchasing power and leaves less discretionary income for consumers to spend on goods that keeps the US economy growing. The Federal Reserve is in a tough position because they need to raise rates to try to cool inflationary pressures. If rates rise too quickly, it can stall the economy and lead us into a recession. Fed Chairman Powell continue to indicate they can thread the needle and lead us a to a soft landing, avoiding a recession. While I have no better insight than anyone else, my concern remains that anytime inflation has crossed 5% the US economy has entered into a recession either right away or in short-order (we are currently north of 8%). If we do enter a recession, I think the market has already priced a good bit of this into the current correction. Therefore, I think the current correction could be a case where the markets traded the news and end up buying the event. Either way, recession or not, I think much of the impact has already been factored into the current crash.
What have we been doing and what is our path forward?
Our drive is to control what we can control and remain disciplined to our core beliefs. As we often communicate, our strategic allocations are long-term in nature. We remain committed to holding certain asset classes and allocations through all market cycles as history has proven is the most reliable way to build long-term wealth.
As shared in our last update, our relationship with BlackRock was to extend the depth of our investment team. Each quarter, BlackRock provides us macro-economic research and recommends subtle adjustments to our existing allocations to take advantage of short-term market inefficiencies. The goal is not market timing or altering our long-term view but to provide alpha over the benchmark returns in a consistent and reliable fashion. We have implemented four main themes in 2022, which have enhanced our portfolio performance versus the relative benchmarks. Those adjustments are the following:
· Increased our weighting to commodities and energy stocks (first introduced this adjustment in the second half of 2021 and have increased exposure in 2022)
· Shaved our developed international exposure in favor of increased US value exposure
· Trimmed global financial stocks
· Bought longer duration treasuries as these tend to provide increased stability during volatile periods
Our second quarter trade is scheduled with BlackRock this coming Thursday. Our investment committee will be reviewing their recommendations and we will share our portfolio adoptions in a separate communication. The second quarterly trade was delayed with the increased market volatility as well as the one-off ad-hoc trade we rolled out in March related to the Russia/Ukraine conflict.
2022 actions we have taken:
Tax Loss Harvesting – We have been very proactive at tax-loss harvesting for all clients with taxable accounts. This allows clients to use these realized losses to offset future capital gains. We immediately buy back a similar position to maintain the correct portfolio allocation while ensuring clients are able to participate in the recovery when it occurs. The added value in tax savings from us implementing these trades in real-time can be in the tens-of-thousands of dollars.
Real-Time Rebalancing – We review weekly deviation reports and trade client portfolios back to target based on their portfolio drift. This allows us the ability to buy-low and sell-high without timing the market and allows our client portfolios to remain on target through all market cycles.
Financial Plan Assumptions – In 2021 and 2022, we lowered our long-term capital market investment return assumptions. With sky-high stock market valuations and rock bottom bond yields we felt it was prudent to lower expectations within our financial plans. The good news for our Wealth Management clients is that these drawdowns have been factored into your financial plan results and with the readjusted valuations we should be able to increase our long-term return assumptions in future years.
We understand it is difficult to watch, read, and hear the daily headlines. My best advice is to tune out as much noise as possible. My job is to follow the markets daily, which I do, but I can honestly say that I have not looked at my portfolio once throughout 2022. I have conditioned myself to control what I can control and not to be consumed by things that are out of my control. I expect bear markets to happen and similar to what we do for our clients, I have matched my asset allocation to my risk tolerance and liquidity needs. I know that if I exercise patience the markets will most likely return to all-time highs just as they have after every other preexisting crash. We practice what we preach and in doing so I can focus my energy on the things in life that bring me joy – family, friends, clients, and golf.
Investing is one of those rare activities where doing more is usually a detriment to your long-term results. We will look back at the market crash of 2022 and it will be a historical plot on an upward trendline. I am confident that patience will prevail, and the future will be bright.
We remain so grateful to your continued trust in us. If you have any questions, please don’t hesitate to reach out. We hope you have a wonderful summer!
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